Capital in the Twenty-First Century

Perhaps the last thing the world needs is another review of Thomas Piketty’s Capital in the Twenty-First Century. Piketty’s arguments are by now familiar even to those who have not read his book. The author shows that there has been a tendency in recent decades toward rising inequality in the distribution of wealth. Because the rate of return on investment, undertaken mainly by the wealthy, has tended to exceed the rate of growth of the economy, the rich have grown richer, increasing the share of wealth held at the top. Because governments have reduced tax rates on high incomes, corporate CEOs and hedge fund managers have had stronger incentives to push for lavish compensation packages, pressures that corporate boards and shareholders have been unable to resist. As a result, labour incomes have grown more unequal, allowing these “super-managers” to infiltrate the ranks of the wealthiest.

The capitalist system, for its part, possesses no intrinsic counterweight to these processes. Contra Marx, the rate of return shows little tendency to fall as capital is accumulated and the wealth-to-income ratio rises. At the same time, the economic growth rate, on which the increase in labour incomes depends, tends to slow as economies mature. Only government policy is capable of stemming the movement toward a society where wealth is increasingly concentrated in the hands of a few, where socio-economic status is inherited rather than earned, and where inequality is pervasive.

These arguments and forecasts have already been much debated. But what remains for the readers of this journal is to ask what the implications are for European policy of Piketty’s analysis?

The author is himself not shy about drawing implications. He recommends that European governments should impose an annual tax on wealth, levied at rates that rise from 0% on fortunes below €1m, 1% between €1m and €5m, and 2% above €5m. If applied by all members of the EU, he estimates that this tax would raise an amount equivalent to some 2% of the EU’s GDP. These revenues could be used to reduce public debts from 90% to 60% per cent of GDP over a period of 15 years without requiring further austerity policies. Alternatively, they could be used to renew Europe’s infrastructure, reinvigorate social programmes, allow the EU to complete the transition to renewable energy, or fund a ‘Marshall Plan’ for the more troubled national economies in the EU.

There is little evidence that this modest wealth tax would discourage saving and investment, or depress the rate of economic growth. On the contrary, there’s good reason to think that an annual wealth tax levied at these modest rates would do less to hinder growth than the current fiscal regime, which imposes distortionary taxes on labour incomes and corporate payrolls. Moreover, European countries have successfully levied such capital taxes before, notably in the wake of World War II.

Aside from economic efficiency, there are other rationales for what might be called “the Piketty tax.” With the concentration of wealth comes the concentration of political power, a fact that sits uneasily with a Europe committed to democracy. The idea that socio-economic status conferred mainly by inheritance is similarly uncomfortable for European societies committed to equality of opportunity.

As for the objection that a wealth tax would be tantamount to expropriation, it is worth observing, as Piketty does, that the wealthy would continue to grow wealthier in the face of a 2% wealth tax so long as the rate of return on capital exceeds 2%, which it has by a considerable margin for the last 150 years. The only difference is that the wealthy would not necessarily continue to increase their shares of national income and wealth.

But saying that there are sound arguments for a progressive wealth tax is not the same as saying that European countries will adopt one. Piketty exaggerates the ability of individual European countries and, for that matter, the European Union as a whole to do so unilaterally. Were one country, say, the UK, not to go along, one can readily imagine the wealthy citizens of other EU countries relocating their tax residence to London. The EU’s recent agreement with Switzerland shows that through information-sharing, governments can make progress on this evasion problem. But the EU is unlikely to have the leverage over large non-European countries that it enjoys with Switzerland. Agreement on levying or at least enforcing the wealth tax would have to be global in order to be effective. Absent that, evasion would be seen as undermining the legitimacy of the tax regime.

Moreover, it is not hard to anticipate who will push back against the idea of “the Piketty tax” – namely the wealthy, whether through their political allies, their lobbyists or their media outlets. While the euro crisis is serious, it does not rise to the levels of World War II, an existential crisis for European society that allowed their objections to be temporarily overcome. A Europe-wide wealth tax to pay down public debts, for its part, would be opposed by Northern Europeans, who would immediately label it a form of “transfer union” designed to retire the debts of Southern Europeans. Piketty’s book includes many clever ideas, but these do not extend to suggestions of how these sources of resistance might be overcome.

The book also contains a number of more practical suggestions. In addition to new taxes on wealth, Piketty proposes more progressive taxes on current income (something that would probably make more of a difference for inequality in the U.S. than in Europe, given the explosive growth of executive pay in America). He proposes making university education, an important lubricator of social mobility, more affordable (again, something that would make more of a difference in America, where private university tuition costs are very high) and opening up admissions to France’s grandes écoles.